Is a 12.5% return on Woodside's Browse LNG enough for investors?

Given the big risks and potential for problems is a 12.5% margin a 'damn good return' for Woodside's Browse LNG?

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A State enquiry held this week on the use of floating technology to extract and process natural gas into LNG has heard that the margin for Woodside Petroleum's (ASX: WPL) Browse LNG project could be between 11.5% and 12.5%.

The review heard how an un-specified major oil and gas company has stated that an onshore processing option at James Price Point would likely return 11.5%, while the lower cost of a floating LNG (FLNG) option could return 12.5%.

It is a fascinating insight for investors who are often not privy to estimated project returns before they are underway. It may also have some investors wondering "is that all"?

There can be huge risks involved in projects on the scale that Browse is, and small percentage changes to costs from delays, cost increases or currency fluctuations can quickly eat into a 12.5% margin.

The PNG LNG project being completed by Oil Search (ASX: OSH) and Santos (ASX: STO) is a case in point. The project was initially budgeted at US$15.7 billion, but is now expected to finish 21% higher at US$19 billion. The significant cost over-run was in part attributed to the negative impact of foreign exchange rates over the project period.

Woodside does not publically discuss capital costs or commercial terms used to evaluate the joint ventures it enters. Nor does it disclose the 'hurdle rates' or return on investment targets it has set for evaluating its projects.

In an investor release earlier this year Woodside said it had applied its usual commercial hurdle rates to the Browse project and it was not met by the James Price Point option.

Back in 2007 then Woodside chief executive Don Voelte was asked about the expected return on the Pluto LNG project given the massive investment. In response, Mr Voelte is quoted by the Sydney Morning Herald saying: "I don't spend $11 billion unless I get a damn good return on it."

Foolish Takeaway

In spite of conventional investment wisdom that says that big risks should be compensated with big rewards, the large scale of the Browse project and Woodside's history of success suggests investors can be reassured the company is chasing an acceptable return for the risks it is taking.

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Motley Fool contributor Regan Pearson does not own shares in any company mentioned.


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